The Basics of Retirement Plans, and the Military’s Old and New Plans

1 April 2018

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One unexpected benefit of the introduction of the “new” military retirement system, the Blended Retirement System (BRS), is that a lot of people have discovered that they don’t understand their retirement plan at all. While it isn’t great that folks don’t thoroughly understand the system, this is a great opportunity for learning all around.

First, let’s start with the basics of all retirement plans. Almost every employer retirement system, no matter who you work for, is some combination of two different types of plans: a defined benefit plan, or a defined contribution plan. Some companies may offer just one type, and some companies may offer both. Most retirement plans require some sort of vesting, which is when you can get benefits from the plan.

Vesting

Vesting is an important term that can be used with either defined benefit or defined contribution plans. Merriam-Webster defines vesting as “the conveying to an employee of inalienable rights to money contributed by an employer to a pension fund or retirement plan especially in the event of termination of employment prior to the normal retirement age.” Translated, that means that when you are vested, you have the rights to either the defined benefit or defined contribution funds that were contribute by your employer.

There are many different ways to set up vesting. The two most frequent are cliff vesting, where you have no rights to the retirement funds until you have worked for the company for a certain number of years, and graded vesting, where you earn the rights to a certain percentage of benefits after certain terms of service. Military retirement pay is an example of cliff vesting, where you earn no retirement pay unless you serve for 20 years(or are eligible for a special retirement program.) An example of graded vesting is the Navy Exchange 401(k) program, in which you are 25% vested in the NEXCOM contributions after 1 year of service, 50% vested after 2 years of service, and 100% vested after 3 years of service.

It is important to note that vesting only applies to the money that your employer contributes to your retirement benefits. Any money you contribute to your retirement benefits remains yours at all times.

Defined Benefit Plans

A defined benefit plan is a plan that has a set amount of benefit based upon certain criteria. Military retirement pay, or the militarypension, is an example of a defined benefit plan. Defined benefit plans can have all sorts of rules about:

when you are eligible to start earning benefits

how you earn the benefits (for example, based on years worked, or earnings, or age)

when and how you can receive the benefits.

Defined benefit plans may or may not require employee contributions. Either way, the individual money is not designated to an individual employee, but rather all the funds are mixed together and held by the employer, or their retirement plan holder. The amount of benefit does not change based upon the performance of the investments in the account (unless the account goes bankrupt, which is a subject for another day.)

Defined benefit plans may have either cliff vesting or graded vesting, and/or they may require that you work to a certain age to receive benefits.

Defined Contribution Plans

A defined contribution plan is a special kind of investment account. Most current retirement plans, such as 401(k) plans, are defined contribution plans. The federal government and military’s Thrift Savings Plan (TSP) is a defined contribution plan.

The employee, and sometimes the employer, contribute various amounts to the account throughout the employee’s working career. The employee owns the balance of the account (with vesting restrictions) and can transfer it with them between jobs. The money remains separate from the funds of other employees, and the value of the account will increase or decline with the value of the investments in the account.

Defined contribution plans often include an employer contribution. There are four main ways an employer can contribute to their employees’ defined contribution plans (from Zenefits.com)

Percentage match: The employer contributes a percentage of the salary an employee defers into the 401k account

Fixed match: The employer contributes $1 for every $1 the employee defers to the plan up to a defined contribution ceiling, such as 6% of pay

Blanket contribution: The employer makes a blanket percentage contribution for all employees regardless of whether they defer pay into the 401k plan

Multi-tier formula: The employer’s contributions decrease as the employee’s deferment increases. So, an employer might contribute dollar for dollar on the first 3 percent of pay contributed and 50 cents per dollar on the next 3 percent of pay.

Military Retirement, Old and New

Both of the military’s retirement plans, the old legacy retirement system and the new BRS, offer both defined benefit and defined contribution components. Military retirement pay, or a military pension, is the defined benefit portion. The Thrift Savings Plan (TSP) is the defined contribution portion. There are four major differences between the two plans, but only two of them are relevant to this article. The legacy retirement system includes a larger defined benefit pension, but does not offer any government blanket contributions (also called “automatic contributions”) or government matching funds for contributions to the defined contribution Thrift Savings Plan (TSP). The new BRS offers a smaller defined benefit pension and also includes an automatic government contribution and government matching contributions to the employee’s TSP account.

The Defined Benefit, or Pension

In both military retirement plans, the defined benefit portion is based upon years of service and “high three base pay,” which is the average of the highest 36 months of base pay received while serving. Both plans also have 20 year cliff vesting: before 20 years of service, you receive no benefits, and after 20 years of service, you are eligible to receive benefits. Neither military retirement plan requires an employee (service member) contribution to the defined benefit portion of the retirement system.

The difference in the defined benefit portion of the two plans is how much of the high three base pay is applied to calculate the amount of the military retirement pay, or pension. Under the old, legacy plan, the formula is 2.5% of high three base pay times years of service. Under the new BRS plan, the formula is 2.0% of high three base pay times years of service.

The Defined Contribution

In both plans, employee contributions to the defined contribution portion, the Thrift Savings Plan, are optional. Under the legacy system, there are no government contributions to the TSP account. Under the new BRS, the government contributes 1% of the service member’s base pay as an automatic contribution, even if the service member contributes nothing. This starts after 60 days of service. Then, there is a multi-tier formula of government matching contributions available after 2 years of service. The Department of Defense (DoD) will match, dollar for dollar, the first 3% of a service member’s contributions to TSP, and will match 50 cents per dollar contributed for the next two percent. Together, with the automatic contributions and matching contributions, the DoD will contribute 5% if the service member contributes 5%. This matching continues from the end of the 2nd year of service to the end of the 26th year of service.

Since there is no government contribution to the defined contribution portion under the legacy retirement system, there is no vesting. Under the new BRS, there are different vesting rules depending on when you entered the military. If you entered the military prior to 31 December 2017, and opted-in to the BRS, then you are automatically vested into any government matching funds, and are vested in automatic government contributions after 2 years of service. If you entered the military on or after 1 January 2018, and are automatically in the BRS, then you will be fully vested in the government contributions to your account after you reach two years of service.

You can read much, much more about the Blended Retirement System in these articles:

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